• New York's Unfunded Pension

    Photo of NYC from Rockefeller Center by Daniel Schwen, used by permission Creative Commons http://commons.wikimedia.org/wiki/File:NYC_wideangle_south_from_Top_of_the_Rock.jpg




    New York is number one when it comes to pension liability with $66.5 billion in unfunded obligation, according to Bloomberg (Klopott, 25 Nov 2013).


    From the article:


    The liability of the third-most-populous state surpassed that of California, which has a $65 billion unfinanced burden, according to an S&P report released today. New Jersey was third with $64 billion in other post-employment benefits. Oklahoma had the lowest. States’ collective burden was about $529 billion. The company said it used the most recent figures available, from2012 or earlier.


    For discussion:


    What does it mean for a pension obligation to be “unfunded?”


    What factors cause the pension obligation to increase or decrease?


    What can a state or employer do to reduce the amount of the unfunded liability?


  • Is the Future of Open Outcry Trading Bleak?

    Photo by Kreepin Deth (Own work) [CC-BY-3.0 (http://creativecommons.org/licenses/by/3.0)], via Wikimedia Commons


    The London Metal Exchange (LME) looks nothing like the movies. It is very civilized and orderly with traders dressed in dark business suits seated in a ring on a round leather couch to buy and sell the commodities that are traded in the ring.

     Unfortunately the ring, like all open outcry pit traded exchanges, is having trouble competing with electronic trading venues.

     According to Bloomberg (Troszkiewicz and Kolesnikova, 25 Nov 2013), Jeffries Group, Inc has joined Barclays Plc as a Category 2 member of the LME and will no longer trade on the floor of the exchange but rather will limit trading to electronic and telephone trading.

     From the article:

    The change leaves 10 companies including JPMorgan Chase & Co. and Societe Generale SA entitled to trade on the LME floor, known as the ring. Transactions taking place in the ring account for about 5 percent of volume, excluding phone trades that are based on ring prices, according to the exchange. Hong Kong Exchanges & Clearing Ltd. pledged to maintain floor trading until at least January 2015 when it bought the LME last year.

     “The ring is clearly struggling,” said Wiktor Bielski, an analyst at VTB Capital in London with more than 30 years of experience in metals and mining. “In the old days, ring-dealing membership was highly sought after. Now, with screen-based trading having taken over so much, you’ve got to think that unless you are really 100 percent committed to physical, it’s hard to justify paying the fees.”


    For discussion: 

    What are some of the benefits and limitations of open outcry trading versus electronic trading?


  • Are You A Better Saver Than Your Parents?

    A recent study found that millenials—young people in their 20s and 30s—are better savers than they get credit for.


    From the article (Taylor, 22 Nov 2013):


    Indeed, according to a study by online brokerage TD Ameritrade, younger Americans are hardly the slackers they are often portrayed to be. The vaunted baby boomers - those born between 1946 and 1964 - started saving for their golden years at age 35. Meanwhile, Generation X (born in the late 1960s and 1970s) started much earlier, at 28.


    And Generation Y, born in the 1980s and 1990s, bested both of them. They began at an average age of 24.


    "The savings habits of younger investors are actually much better than the perception," says Lule Demmissie, managing director of retirement for TD Ameritrade.


    For discussion:


    Based on the article cited above, what are some reasons that young people save more in their 401ks than their parents saved?


  • Venture Debt or Venture Capital?

    We’ve heard about venture capital for years. Now companies are turning to venture debt to raise funds for expansion. This is the classic question: which form of capital is more suitable: debt or equity? For a typical publicly traded firm, each form of capital offers benefits and limitations. And this holds true for a start-up firm too.


    For discussion:


    Based on this Bloomberg video, what benefits and limitations can you identify for venture debt?


    How do you think these characteristics of debt capital might differ for more mature, publicly traded firms?


  • The Cost of Bank Fraud

    American Banker reported that bank call centers are a top target for fraud (Crosman, 21 Nov 2013):


    From the article:


    Pindrop found that one in every 2,500 calls affecting financial institutions is fraudulent. Some scam calls are for reconnaissance purposes, some are to make account profile changes that could be used to steal money, others are requests to replace a debit or credit card. Over the first six months of 2013, Pindrop observed phone fraud attempts ranging from a few thousand dollars to as much as $800,000. An institution that takes 50,000 calls a day loses an average of $28,500 a day and slightly over $10 million a year in phone fraud losses, the report estimates.


    The FDIC defines operational risk as, “Risks associated with operational failures stemming from events such as processing errors, internal and external fraud, legal claims, and business disruptions” (Read the FDIC article here).


    Banks have always contended with operational risk. In the old days, bank robbers slipped a note to an unsuspecting bank teller and the teller tried to sneak a dye pack into the bag of loot while simultaneously pressing the silent alarm. Todays criminals are much more savvy, choosing cybercrime over the traditional hold-up. With technology at their fingertips, bank robbers use information rather than guns to grab what isn’t theirs. Meanwhile, banks are left to determine how they can manage their operational risk and stay in business.


    For discussion:


    What are some examples of operational risk facing a bank? How can a bank minimize or control the cost associated with operational risk?


  • Should Tax Rules Be Changed For Non-Manufacturing Firms?

    What are the most valuable assets of the firm? Are they the physical property, plant, or equipment? Or are they the human capital and technology? In today’s market, manufacturing has been replaced by knowledge work. And some suggest that accounting practices should be modified to suit this brave new world.


    According to the NY Times article, “Tax Proposal for an Economy No Longer Rooted in Manufacturing” (Fleischer, 21 Nov 2013):


    Under current law, cost recovery (better known as depreciation) is accelerated, meaning that the value of assets can be written off for tax purposes faster than the assets actually decline in value in economic terms.


    Accelerated depreciation has a long history rooted in the goals of the 20th century manufacturing economy. Facing the rising threat of world war, Congress introduced accelerated cost recovery in 1940 to encourage investment in property considered necessary for the national defense. (Before acquiring property that would benefit from accelerated depreciation rules, taxpayers had to seek a certificate of necessity from the War Production Board.) Liberal depreciation allowances were expanded with the enactment of the 1954 Internal Revenue Code. The current accelerated depreciation system was in place by the 1980s, and revised in the 1990s, again with an eye toward encouraging investment in productive machinery, equipment and other tangible assets.


    But it is no longer clear that we should use the tax system to encourage investment in tangible assets. After all, a system that encourages investment in tangible assets makes investments in other assets — intangible assets and human capital — look worse by comparison.


    For discussion:


    What are the types of assets identified in this proposal? Which types of firms or industries would you expect to be in favor of the tax changes proposed by Senator Baucus? Who might be opposed?


  • Is The "Invisible Hand" Too Invisible?

    photo by y Agnico-Eagle (Agnico-Eagle Mines Limited) [CC0], via Wikimedia Commons



    In 1759 and 1776, Adam Smith introduced the concept of the invisible hand of the market where self-interested market participants compete and drive prices to equilibrium. Thus market equilibrium is the optimal price at which all participants benefit.


    Unfortunately, the invisible hand has been a little too invisible lately with some pretty sticky fingers, sparking all manner of investigation into price fixing and collusion. Beginning with LIBOR manipulation and more recently, currency manipulation, regulators have been busy determining whether free markets are indeed free or whether they’re locked up by a few powerful players.


    A recent Bloomberg article (Ring, 20 November 2013) reports that gold is the latest market to be investigated, though the investigation is not yet official.


    From the article:


    The U.K. Financial Conduct Authority is reviewing gold benchmarks as part of its wider probe of how global rates are set, a person with knowledge of the matter said.


    The FCA review is preliminary and hasn’t risen to the level of a formal investigation, said the person, who asked not to be identified because the matter isn’t public. The person declined to say which gold benchmarks were under scrutiny.


    Have markets become more unethical? Here’s one perspective:


    “It’s another indictment perhaps of the lack of oversight in many markets,” O’Neill said of the FCA review. “Certain things that may have been considered acceptable before are not now. It may not be that things have gotten worse. It just may be that there’s more scrutiny.”


    For discussion:


    What is the London Gold Fixing and how does it work?


    What is the invisible hand, and is it successful? Why or why not?


  • Will Short Sellers Win?

    In the absence of short selling, investors can only profit if prices of investments rise. If investors believe prices will fall, then the best they can do is to get out of the market, but they can’t benefit from a declining market.


    This is the restriction faced by traditional mutual funds, also dubbed “long only funds.” Hedge funds, on the other hand, can take advantage of a bullish viewpoint by going long, and they can take advantage of a bearish viewpoint by going short—hence, they are called, “long-short funds.”


    According to this CNBC article (Delevigne, 20 Nov 2013), some hedge funds see this current market high as a great opportunity to short the stock market:


    With the Dow Jones industrial average flirting with 16,000, hedge fund managers that focus on betting against stocks see a once-in-a-lifetime opportunity to make money on what they see as an epic equity bubble.


    "This is it. It's the bottom of the ninth and we're about to hit a home run," said John Fichthorn, co-founder of Dialectic Capital Management and an expert on shorting stocks. "I believe this is the best opportunity I will see in my life as a short seller."


    Virtually every other so-called short-biased hedge fund agrees, practically jumping up and down to alert investors of the opportunity to make money when the stock market falls significantly.


    The question, of course, is when and if the managers can survive as businesses long enough to see the big returns they are so convinced are coming.


    For discussion:

    How does a short sale work? How does an investor benefit from a short sale? What is the maximum gain and maximum loss associated with a short sale?


  • And For Our Next Market Manipulation: Foreign Currency

    The NY Times reported this week that the U.S. Attorney General’s office is investigating suspected currency manipulation by a “cartel” of international banks.


    From the article (Protess, Thomas, and Bray, 14 Nov 2013):


    But coming fast on the heels of a similar investigation into the rigging of global interest rates, the latest scrutiny has unnerved the world’s biggest banks, setting off internal scrambles to contain the damage. Nine of the largest banks in currency trading have announced they are facing inquiries. The banks placed about a dozen traders on leave pending the outcome of the inquiry. And several banks are considering limiting the ability of their traders to chat electronically.


    The priority that investigators are giving the case, which focuses on trading over the last decade, reflects the significance of the market in the world’s major currencies itself. With trading of more than $5 trillion a day, it dwarfs any stock or bond market.


    For discussion:


    According to this Bloomberg article (Schoenberg, 12 Oct 2013), how did the alleged currency manipulation take place?


  • "Well, this is it. The last bastion of pure capitalism left on earth"

    Buy low, sell high. Fear? That's the other guy's problem. Nothing you have ever experienced will prepare you for the absolute carnage you are about to witness. Super Bowl, World Series - they don't know what pressure is. In this building, it's either kill or be killed. You make no friends in the pits and you take no prisoners.


    ~ Louis Winthorpe III played by Dan Ackroyd

    From the movie, Trading Places,  Paramount Pictures 1983


    Title taken from Trading Places





    The days of frantic traders yelling prices and waving their arms are nearly over. The business of stock exchanges has shifted from pit trading to electronic trading, and the once dominant New York Stock Exchange has quietly been eclipsed by smaller, more competitive electronic trading venues.


    From the Economist (16 Nov 2013):


    Making money running a stock exchange is getting harder, thanks chiefly to increased competition. The NYSE once had a monopoly on the trading of shares in firms that listed on it, but regulators did away with that in 2000. Even so, a decade ago it still had a roughly 80% share in the public trading of American equities, according to Bernstein Research; now it accounts for less than 25%. Before ICE made its takeover bid in December of last year, NYSE Euronext’s share-price was languishing at a quarter of its peak. Although new listings in America are at their highest level in a decade after a long decline, the competition means the NYSE will struggle to capitalise on them.


    (Read the full article here)


    The title and quote at the top of this post refer to a popular 1980s movie starring Dan Ackroyd and Eddie Murphy. The movie depicted commodities trading, not stock trading. But the lines from the script once held true for the NYSE.


    For years, the NYSE was the emblem of stock markets. Today, the New York Stock Exchange may no longer be the last bastion of pure capitalism that it once was.


    For discussion:


    What are “dark pools?” What are some of the forms of competition that the NYSE faces?


    What are “derivatives?” In what ways do derivatives exchanges differ from stock exchanges?


  • Do You Have Enough Savings To Retire?

    Message to graduates: start saving as soon as you start earning.


    But what if you haven’t saved enough, and now you’re 55 with far too little in your retirement fund?


    This CNBC article (McBride, 15 Nov 2013) suggests that as we approach retirement, we consider (1) cutting spending asap, (2) continuing to work, (3) investing in stocks, and (4) selling the house to take advantage of the equity.


  • The Cost to Unwind Derivatives

    Bloomberg recently reported that Harvard University paid $345.3 million to unwind interest rate swaps. This brings the total cost of unwinding these contracts to over $1.25 billion since 2008.


    From the article (Lauerman and MacDonald, 8 Nov 2013):


    The school agreed to many of the swaps when former President Lawrence Summers was planning to build the Allston campus, including a $1 billion science center. The swaps, which locked in interest rates for Harvard, also required the school to post collateral if rates fell. Harvard officials said that the hedges on debt that remain are unrelated to Allston.


    After Drew Faust succeeded Summers as president, the school terminated swaps to avoid posting millions in collateral. Faust put the expansion plan on hold as Harvard’s frayed finances forced the school to take budget-cutting measures, including cutting some student services.


    The school’s losses on terminating the swaps since 2008 were $497.6 million in fiscal 2009; $277.6 million in 2011; and $134.6 million in 2012.


    For discussion:


    1.    According to the 2013 article above and this 2009 Bloomberg article on the same topic, why did Harvard enter into these swap contracts in the first place? Why did they seek to terminate them early?


    2.   How do you respond to the following statement made by Philadelphia Councilman James Kenney (23 October 2012, p. 6):


    Also, the aspect of swaps that are particularly galling to me is the necessity of having to buy our way out of a bad deal. I was here when we were dealing with swaps back when it happened and we were told it was a good deal for the taxpayer. I believe that some of the bad actions of the banking institutions in our country threw our economy off the cliff, which put governments and school districts on the wrong side of swaps. That’s galling enough that they’re making money, we’re losing money, but if we want to get out of the deal, we have to pay them to get out of the deal.


  • On Average, They're All Average

    On Aug 31, 1976 John C. Bogle launched the Vanguard 500, the world’s the first index mutual fund. The idea was that after fees, investment managers could only hope to match the market return. Nothing more.


    From the NY Times (Sommer, 11 Nov 2013):


    Today, while thousands of stock pickers and individual bond buyers still proudly ply their trades, index funds have swept the world. Including exchange-traded funds — nearly all of which are a form of index fund — more than $3 trillion in assets are now invested in index funds, according to the Investment Company Institute, the industry’s trade group. The question now is not whether low-cost, diversified, broad-market index funds have any value, it is how much they can be improved.


    (read the full article here)


    While index funds remain as popular as ever, a new breed of mutual funds—fundamental index funds—has joined the scene. These funds choose a specific strategy that seeks to outperform the market.  


    Whether these new funds will outperform the market over the long run remains to be seen.


    For discussion:


    What are some strategies followed by fundamental index funds? Do these funds try to minimize tracking error? Why or why not?


  • The Twitter-NYSE Partnership

    This past week has been all things Twitter. The success of the IPO made headlines and, according to this CNBC article, that success is partly due to the NYSE listing of Twitter shares.


    From the article:


    Twitter chose the NYSE not necessarily because of its storied past and evolution into the automated universe of electronic execution, but for its personal attention to detail. This is critical and remarkably valuable when finalizing multi-billion deals; and it's an X factor the electronic marketplaces just can't learn. Investment bankers and dealmakers realize these attributes are why the Twitter IPO was such a huge success.


    The NYSE is about to rewrite its own story when the IntercontinenalExchange (ICE) finalizes its takeover of the company that started under a buttonwood tree way back in 1792. The deal is expected to close next week; and even though execs at ICE have said they plan to keep the trading floor, the financial services sector realizes this is not a binding promise. The end may not be around the corner, but it unfortunately isn't far away either.


    For discussion:


    Based on this Bloomberg article, how did the Twitter IPO compare with the Facebook IPO?


  • Buy Low Sell High Still Works

    Be fearful when others are greedy, and be greedy when others are fearful.

    ~ Warren E. Buffet, NY Times Op-Ed, 16 October 2008



    The financial world was crumbling. Subprime mortgages and their derivatives had caused an unprecedented credit crisis. The collapse of Bear Stearns was soon followed by Lehman Brothers, and in 2007-09 folks headed for the hills with the shotgun and the dog.


    But not everyone.


    Some were buying. Warren Buffet described his strategy in a NY Times op-ed piece in 2008. His plan? Buy U.S. stocks.


    Other “Treasure Hunters of the Financial Crisis” found bargains too. A recent NY Times article describes the success of Oaktree Capital Management and other financial firms who saw buying opportunities where others saw nothing but bankruptcy.


    From the article (Latman, 9 Nov 2015):


    So Mr. Karsh, through his Oaktree Capital Management firm, plowed money into distressed debt at a torrid pace, investing more than $6 billion over a three-month stretch.


    “Unless the second Great Depression lies ahead,” Howard S. Marks, Oaktree’s chairman, wrote to their clients on Oct. 6, 2008, “today’s purchases should produce substantial returns, and in a few years we’ll reminisce together about how easy it was to take advantage of the bargains of 2008-09.”


    It paid off. With the help of an extraordinary government bailout and stimulus, the second Great Depression never came and a global recession eventually faded. A half-decade later, Mr. Marks’s prediction has come to pass. Virtually all of the debt bought on the cheap has fully recovered in value. The trade yielded spectacular profits, earning about $6 billion in gains for Oaktree’s investors and $1.5 billion for Mr. Karsh, Mr. Marks and their partners.


    (Read the full article here)


  • When Renting is More Expensive than Buying

    This CNN Money article (Ellis, 7 Nov 2013) reports that the number of customers that rent to own has increased dramatically:


    Since the financial crisis began, the number of rent-to-own customers has surged 50%, from 2.8 million in 2007 to 4.2 million last year, according to industry group the Association of Progressive Rental Organizations (APRO). Annual revenue among retailers in the industry spiked 35% during that time -- to $7.9 billion last year. And as of last year, there were nearly 9,000 rent-to-own stores in the United States.


    Here's how it works: At Buddy's Rents, for example, you can rent-to-own an LG 42-inch plasma TV for as little as $22.99 a week. You can return the TV any time if you don't want to keep it. But in order to own it, you need to make 78 payments or a total of $1,793. That compares to a retail price of $446 on Amazon.com.


    This article lays a case for purchasing the item outright rather than paying in installments. And, in addition to the purchase versus using installment loan, there is often a third option. Not buying the item at all.


    For discussion:


    Who are the typical customers at a rental center?


    Are there any benefits to having a rental center in your hometown? What about limitations?


    How much does it cost to buy an item using rent-to-own compared with what it would have cost to buy the item outright?


  • Can Low Risk Lead to High Returns?

    Modern portfolio theory says that higher risk leads to higher returns. Higher systematic risk, that is. Stocks with high systematic, or market, risk have returns that are more sensitive to market returns, and therefore should earn more than the market earns. This sensitivity is measured by beta.


    This theory suggests that all returns are proportional to their risk, and so any investment that outperforms the market is simply more risky than the market.


    But not all investors agree. Research has suggested that some shares with low risk are associated with higher returns. Such shares are called “value shares.”


    According to a recent MarketWatch article (Arends, 8 Nov 2013):


    The most important factor in investment performance is the price you pay for stocks. Investors in the main tend to pay too much for sexy “growth” stocks with exciting stories, and undervalue the virtues of dull, boring, slow-growth companies — even though they may have tons of cash flow today and tomorrow. The net result is that investors have been able to gain a big edge over time by going against the crowd.



  • Meet the Dealmaker

    This Bloomberg video gives a glimpse of the man who made history. Jimmy Lee of JP Morgan Chase is the “famed deal maker” who brought us Facebook and Twitter IPOs. With his highly sought after position in financial markets, Lee is involved in the big IPOs that are important to JP Morgan.


    For discussion


    What are some of the factors that have contributed to Jimmy Lee's success?


  • LinkedIn or Yelp?

    Which social network is most important to you? Facebook, Yelp, LinkedIn?

    According to this CNBC interview, LinkedIn offers investors the strongest possibilities. For new graduates, LinkedIn is the only social network that offers job search prospects and is the one that young people are least likely to give up.


    For discussion:


    Is LinkedIn a growth stock? Why or why not?


    What fundamental factors make LinkedIn a good investment?


  • How Much Cash is Too Much?

    For years, agency theory has suggested that companies with too much free cash flow get themselves into trouble. Berkshire Hathaway is in just this position with $40 billion in cash.


    According to this Bloomberg interview, Warren Buffet, the famed CEO of Berkshire Hathaway is known for choosing to hold a generous cash reserve, but even he would agree that $40 billion is a little high. Disadvantages of too much cash include the drag associated with low earning power of cash, but the flexibility to invest in new ventures and ability to meet unexpected obligations require Berkshire Hathaway to have some cash on hand.


    For discussion:


    What other benefits and limitations are associated with an overly high cash reserve?


  • Active Managers Avoid Apple Stock

    Active portfolio management means picking specific stocks or bonds or sectors of the market in which to invest. Passive investment, on the other hand, seeks to simply mimic the market—no better and no worse.


    So how does an active portfolio manager “beat” the market?


    Some may try technical analysis: buying and selling based on trends or price and volume signals. Others may try fundamental analysis: buying and selling based on earnings or other bits of information.


    Oddly enough, many active managers try to beat the market by buying whatever other active managers are buying—a behavior called “herding” in the academic literature. This herding mentality was seen most recently in the tendency to hold Apple stock in nearly every portfolio. Today, that strategy has shifted.


    According to CNBC (Cox, 1 Nov 2013):


    The past couple years for active managers have been rough, but things have gotten better this year thanks to one key strategy: Not owning Apple.


    While it once might have seemed unthinkable that avoiding the tech titan would be good for a portfolio, this year's weak performance has caused investment pros to do just that.


    Apple recently lost its coveted spot as the most-owned stock by mutual funds, ceding the position to Google, though it's still No. 2 on the list.


    For discussion:


    According to The Arithmetic of Active Management” by William F. Sharpe, why should active management underperform passive management?


    What are some of the techniques used in technical analysis? What are some of the techniques used in fundamental analysis? What does the efficient market hypothesis say about the ability to outperform by using technical and fundamental analysis?